We expect moderate returns from the region’s stock markets in 2020 as the major engines of global growth (China and the US) are both slowing and US-China tensions are likely to rumble on keeping sentiment in Asia subdued.
Although Chinese economic growth is slowing, we expect to see an expansion in newer parts of the economy, such as e-commerce, education, leisure and travel. The “upgrading” trend is also set to continue, with Chinese consumers willing to spend more on higher end discretionary products and services.
Stock selection will remain the key to returns in 2020 as growth will only come from companies that are able to survive and thrive amid such an uncertain economic backdrop. We still think China offers the most exciting stock picking opportunities.
The events of the past year or two have made Asian markets feel less bound by economic fundamentals and more hostage to unsettling political developments. Many of the long-held assumptions underpinning our Asian investments – such as the merits of global free trade or the rule of law and stability of Hong Kong SAR – are being radically challenged.
The ongoing US-China trade dispute has sapped momentum in many regional economies and we don’t expect any major upswing in economic growth as both the Chinese and the US economies are slowing. As a result, we aim to take a micro, rather than macro, approach to stock selection. This involves seeking companies that have the ability to achieve growth based on their competitive advantage or ability to grow market share, rather than due to the economic cycle.
China offers the best opportunities for stock pickers
Headline growth in China has slowed considerably in recent years, with nominal GDP now around the 6% to 7% level, compared with between 15% and 20% at its peak. However, there has been a dramatic explosion in the growth of “newer” parts of the economy as the service sector takes over the baton for economic development.
E-commerce continues to grow many times faster than underlying retail sales. At the same time, sectors such as healthcare, education, travel and leisure now account for a greater share of consumer spending, with growth rates much higher than the wider economy.
Meanwhile, the “upgrading” trend is set to continue, with Chinese consumers spending more on high-end products. So, even if volumes are not growing as fast, selling prices and margins are being boosted for companies exposed to these trends. With the opening up of the A-share market in the last few years, there are now even more opportunities to gain exposure to these trends and we continue to see China as the most exciting stock picking opportunity in the region.
Disruption is here to stay
Technological developments, changing business models, environmental pressures and changing consumer tastes are powerful drivers of disruption in Asian markets. And while these trends have enabled the creation of innovative new businesses, such as Alibaba, they also wreak havoc in many of the more traditional stocks in which we invest.
Traditional retail and media stocks have already been decimated by the onslaught of e-commerce. The disruption is now spreading wider, with the revenues of banks being weakened by new “fin tech” companies and automakers struggling to cope with the shift from petrol to battery technology.
Worries over disruption have caused share price falls in some traditional sectors and stocks can appear cheap on headline valuation multiples. However, we think these kinds of business model disruptions are potentially more damaging than trade wars or cyclical economic slowdowns. We continue to view many of the out-of-favour sectors as value traps and are cautious on banks, autos, cyclical, heavy industry and commodity names.
Inflation and interest rates likely to remain low
With growth subdued and disruption continuing, inflation is likely to remain depressed and interest rates very low. Against this backdrop, equity dividend yields offer attractive returns that are now well above risk free rates in most Asian markets. Pay-out ratios are still fairly modest in many cases, aggregate balance sheet leverage is below international averages and we have not seen returns boosted by buy-backs to the levels seen in the US.
As a result, there is considerable potential for pay-outs to increase as companies become more willing to distribute surplus case to shareholders. In a low growth world, we are happy to hold stocks where the bulk of the return is likely to come from dividends providing we see the potential for dividends to be sustained or ideally grow.
Tech sector could offer growth potential
Many tech stocks have been out of favour for the past two years as global smart phone sales have flattened in the absence of any new must-have app to prompt consumers to upgrade. However, the digitisation of the global economy continues to accelerate, which will be positive for key Asian technology stocks at the heart of these developments. The imminent launch of 5G networks in many Asian markets over the next two years should bolster demand and we see attractive opportunities for our preferred names in the IT sector.
Strategy remains balanced
Our strategy for Asian equities remains balanced as we move into 2020. Overall market valuations in Asia look reasonable against historical comparisons. However, this masks the fact that sectors such as banks, autos and commodities drag down the headline valuations. The valuations of stocks we want to own are definitely not cheap, so we anticipate moderate returns from the region. However, we have a strong long-term conviction on where the best opportunities are in Asia. These include stocks in sectors such as Chinese consumption, insurance, technology, real estate in Singapore and Indian private sector banks.
You can read and watch more from our 2020 outlook series here
The opinions above include forecasted views that should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors, they should not be taken as advice or a recommendation to buy and/or sell.
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